Does Sinopec Shanghai Petrochemical (HKG:338) Have A Healthy Balance Sheet?

Howard Marks put it nicely when he said that, rather than worrying about share price volatility, 'The possibility of permanent loss is the risk I worry about... and every practical investor I know worries about.' So it might be obvious that you need to consider debt, when you think about how risky any given stock is, because too much debt can sink a company. We can see that Sinopec Shanghai Petrochemical Company Limited (HKG:338) does use debt in its business. But the real question is whether this debt is making the company risky.

When Is Debt A Problem?

Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. However, a more frequent (but still costly) occurrence is where a company must issue shares at bargain-basement prices, permanently diluting shareholders, just to shore up its balance sheet. Of course, plenty of companies use debt to fund growth, without any negative consequences. When we think about a company's use of debt, we first look at cash and debt together.

Check out our latest analysis for Sinopec Shanghai Petrochemical

How Much Debt Does Sinopec Shanghai Petrochemical Carry?

You can click the graphic below for the historical numbers, but it shows that as of September 2021 Sinopec Shanghai Petrochemical had CN¥6.34b of debt, an increase on CN¥3.04b, over one year. However, its balance sheet shows it holds CN¥9.52b in cash, so it actually has CN¥3.17b net cash.

How Healthy Is Sinopec Shanghai Petrochemical's Balance Sheet?

The latest balance sheet data shows that Sinopec Shanghai Petrochemical had liabilities of CN¥16.0b due within a year, and liabilities of CN¥852.7m falling due after that. On the other hand, it had cash of CN¥9.52b and CN¥4.42b worth of receivables due within a year. So it has liabilities totalling CN¥2.93b more than its cash and near-term receivables, combined.

Of course, Sinopec Shanghai Petrochemical has a market capitalization of CN¥33.2b, so these liabilities are probably manageable. But there are sufficient liabilities that we would certainly recommend shareholders continue to monitor the balance sheet, going forward. While it does have liabilities worth noting, Sinopec Shanghai Petrochemical also has more cash than debt, so we're pretty confident it can manage its debt safely.

Although Sinopec Shanghai Petrochemical made a loss at the EBIT level, last year, it was also good to see that it generated CN¥2.4b in EBIT over the last twelve months. There's no doubt that we learn most about debt from the balance sheet. But it is future earnings, more than anything, that will determine Sinopec Shanghai Petrochemical's ability to maintain a healthy balance sheet going forward. So if you're focused on the future you can check out this free report showing analyst profit forecasts.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. Sinopec Shanghai Petrochemical may have net cash on the balance sheet, but it is still interesting to look at how well the business converts its earnings before interest and tax (EBIT) to free cash flow, because that will influence both its need for, and its capacity to manage debt. In the last year, Sinopec Shanghai Petrochemical created free cash flow amounting to 3.5% of its EBIT, an uninspiring performance. That limp level of cash conversion undermines its ability to manage and pay down debt.

Summing up

We could understand if investors are concerned about Sinopec Shanghai Petrochemical's liabilities, but we can be reassured by the fact it has has net cash of CN¥3.17b. So we are not troubled with Sinopec Shanghai Petrochemical's debt use. The balance sheet is clearly the area to focus on when you are analysing debt. However, not all investment risk resides within the balance sheet - far from it. These risks can be hard to spot. Every company has them, and we've spotted 1 warning sign for Sinopec Shanghai Petrochemical you should know about.

If you're interested in investing in businesses that can grow profits without the burden of debt, then check out this free list of growing businesses that have net cash on the balance sheet.

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This article by Simply Wall St is general in nature. We provide commentary based on historical data and analyst forecasts only using an unbiased methodology and our articles are not intended to be financial advice. It does not constitute a recommendation to buy or sell any stock, and does not take account of your objectives, or your financial situation. We aim to bring you long-term focused analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material. Simply Wall St has no position in any stocks mentioned.